Is LNG a luxury good?

Economists have their definition of a luxury good which is a good whose demand rises more than proportionately with rises in income – the richer you are the more you buy it.

Liquefied natural gas (LNG) seems to fit the description of a luxury good rather well. But should LNG retain this branding?

Product featuresNatural gas is the near perfect fuel; it’s available, affordable and abundant. It’s clean, relative to coal, has low emissions and is safe to handle. It is highly controllable delivering precise heat exactly where you want it at your desired intensity. It’s fast and very desirable – as nations get richer, their populations are prepared to pay for access to gas, for heat, cooking and manufacturing.

The conversion cost of LNGLuxury goods are costly to make, and LNG is also a remarkably complicated and costly way to deliver gas. First the input gas has to be free of impurities that might clog up the LNG works. Next the manufacturing process needs a large amount of energy to chill the gas down to its liquid state. Then we need speciality steel alloys capable of handling extreme temperatures and pressures that chill the gas.

We need heavily insulated storage tanks and a fleet of cryogenic vessels that cost six times as much as equivalent oil tankers to move the gas to market. Finally, at the receiving end, we need more storage tanks, and a regasification plant to remove all the energy that went into chilling the gas.

Scarcity

LNG is kept scarce by the market structure. It might not feel that way, with all this excess supply floating around, but most LNG is sold on long contracts and is generally not available to markets. The majority of existing contracts stipulate exactly where the LNG is to be consumed, preventing it from finding other markets, competing for those markets, and thus keeping it scarce.

Market penetration

Like luxury goods, the market penetration of LNG is curiously low. Gas provides about 25% of global energy, and of that amount, 85% is delivered by pipelines to consumers. LNG is 15% of the 25%, or about 4% of the global market for energy. That certainly meets the criteria for a luxury item – small exclusive markets. In fact the biggest market has been the energy poor, but economically rich nations of Japan, Korea and Taiwan which account for 80% of LNG consumption.

Capital cost

The capital cost of LNG, particularly the recently built projects in Australia, is a clear sign that this fuel is not for the masses. These projects cost billions to build. The facilities for manufacturing LNG have borne some of the highest construction and labour costs in the world.

The future of LNG is not as a luxury good, however. There’s no more demand coming from Japan, Korea and Taiwan. LNG needs to find new markets.

The future of LNG is to become a mass market fuel that works hand-in-hand with renewables. To achieve this market niche, the LNG sector needs an overhaul to meet the needs of the mass market.

So what needs to change?

Mass markets are those that would not purchase LNG as a high priced elite fuel, but will as a medium-low price clean fuel. How do we improve the attractiveness of LNG as an inexpensive fuel?

Accelerate the build side of LNG infrastructure. The slow pace of construction, the tendency to custom design and build, the lack of collaboration and reuse, contribute hugely to the cost to be recovered through pricing and are all candidates for overhaul. The sector needs more standardisation, less bespoke kit, smaller scale, and modular construction.

Deliver gas wells like a manufacturer. The process of drilling onshore gas wells, particularly in the unconventional fields, the installation of gathering systems, the construction of well heads, still follow too closely the approach taken for conventional wells. These processes need to be handed to engineers from the automotive sector and given free rein to transform them from start to finish.

Operate plants like a utility. The traditional end-to-end LNG value chain needs to behave like a power utility. Power operators have central control rooms that optimize assets, maintain deliverability, buy and sell power when appropriate. Oil and gas still separate their operations side from their commercial side, making it unnecessarily hard to lower costs beyond functional optimisation.

Scale down like the technology sector. Next generation LNG buyers will not be big Asian utilities. They’ll be island economies, remote power plants, smaller cities in China. LNG projects need to scale everything down to match, with smaller production runs, smaller loadings, and simplified contracting.

With effort and determination, we can do it. There’s no time to waste.

Visit our APPEA 2016 website for more information and to register for the papers on the oil and gas sector we’ll be publishing during the conference.

Until recently, Geoffrey Cann was the National Director of Oil and Gas in the Brisbane Australia office of Deloitte, where he focuses on helping oil and gas, coal seam gas and LNG companies address their growth, talent and productivity challenges. Geoffrey is now located in the Deloitte Alberta o...